Make sure the stock you pick is running strong on solid earnings. (Flickr)
What are we looking for:
Stocks on the move with stable earnings.
One of the fallacies often met by retail investors is focusing on ‘hot’ stocks that are trending upwards, and not without good reason. In the Canadian market in particular, momentum investing can often be a successful tactic in obtaining great returns over a long time frame. This said, for the typical retail investor this task proves to be difficult because of the amount of attention needed to keep track of market movements, and the often high turnover that accompanies a momentum style strategy. In addition, momentum investing is often wrought with extreme volatility and requires higher risk tolerances or a longer investing time horizon.
This week, I use Morningstar CPMS to create a strategy that combines technical factors and fundamental stability designed to reduce overall turnover and stay invested in names with stable earnings. The strategy first ranks stocks on the following factors:
- Earnings Variability (this is a proprietary CPMS metric that essentially measures how volatile a company’s earnings are over time, lower scores preferred).
- 1, 3, 9, and 12 month price change (in all cases positive price changes preferred)
To avoid overpaying for trending companies, stocks must be trading near or below their 10Y historical median valuations (measured here by Price to Sales, Price to Earnings, and Price to Book). In the table below, a historic relative P/E of 0.9x implies that the stock is trading at a 10% lower than the historic median P/E ratio.
Only stocks with a Market Float of $360M CAD or above were considered here (this figure represents the median value of the CPMS Database, which consists of 700 Canadian-listed stocks). The portfolio can hold up to 10 positions, never owning more than 3 stocks per economic sector to ensure some diversification across the economy.
What we found
I used Morningstar CPMS to back test this strategy from December 1991, to October 2017. During this process, 10 stocks were purchased and equally weighted with a maximum of 3 stocks per economic sector. Once a quarter, we sell any stocks that rank below the top half of our universe, and replace them with the highest ranked stock not already in our portfolio. Over this period, the strategy produced an annualized total return of 13.9% while the S&P/TSX Composite Total Return Index returned 8.6%.
The below table shows a clear picture of how such a strategy performed in trailing periods:
Additionally, the return distribution of the portfolio are shown here:
The stocks that qualify for purchase into the strategy today are listed in the table below. As always, it is advised that investors conduct their own independent research before buying or selling any security.
|Rank||Symbol||Company||Morningstar Sector||Earnings Variability||1M Price Change (%)||3M Price Change (%)||9M Price Change (%)||12M Price Change (%)||Historic Relative Price to Book||Historic Relative Price to Earnings||Historic Relative Price to Sales||Market Float ($CAD Millions)|
|1||CFW||Calfrac Well Services||Energy||12.8||12.5||58.5||57.3||76.7||1||0.4||0.8||608.1|
|2||TF||Timbercreek Financial||Financial Services||3.7||1.6||2||3||7.6||1||1||1||715|
|3||PPL||Pembina Pipeline Corp.||Energy||7.5||7.3||13.7||6.6||15.9||1.1||0.8||1.1||22982.7|
|5||KL||Kirkland Lake Gold Ltd||Basic Materials||20.8||21.5||13||93.5||146.4||0.9||0.2||0.9||3461.8|
|6||TSGI||The Stars Group Inc.||Consumer Cyclical||17.4||5.1||32.9||41.8||39.2||0.7||0.1||0.7||3365.9|
|7||FN||First National Fin||Financial Services||11.9||2.9||14.4||9.7||12.2||0.9||0.9||0.8||466.4|
|8||LIF||Labrador Iron Ore||Basic Materials||12.4||1||5.3||10.8||20.9||0.7||0.9||0.7||1349.1|
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
Ian Tam is the Manager of the client services team at CPMS, a division of Morningstar that focuses on providing high quality equity fundamental data and disciplined rules-based investment processes to the institutional buyside and investment advisors across North America. Ian completed his Bachelor of Applied Sciences (Hons. Mechanical Engineering) from the University of Waterloo in 2007 and obtained the CFA Charter in 2013.